Investor behavior is probably the most important factor for investment success. Warren Buffett was interviewed for a book called “The Money Masters”, written by John Train in 1980. His investment behavior lessons are still very valuable. Investment behavior is a significant predictor for long-term investment success.
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Successful behavior of the investor according to Warren Buffett
The interview with Warren Buffett reveals some interesting points about investor behavior. Having the right mind-set and attitude towards investing will largely determine your returns over the years. Of importance is: how do you view the market (Mr. Market) and look at market prices? Do you see stocks as businesses and do you have the patience to only buy with a margin of safety (see: Investment Principles).
Let’s dive into the six points mentioned by Warren Buffett.
1. You need to be fascinated by the investment process
Enjoyment and interest in the investment process are crucial according to Buffett. If you don’t enjoy investing, then you’re unlikely to stay motivated over the long-term. This is needed in order to keep up with the business news and results. Furthermore, it will help to keep an positive attitude towards investing.
2. You must have patience
Only buy a stock if you want to keep it at least 10 years and if you don’t care that the stock market is closed for 10 years. Buy it because you think that it will earn more in 10 years, not because of a higher stock price. The higher stock price will be the result of the increased cash flow over time. Which will happen if you buy a good business (see: how Buffett invests).
Discipline is needed for waiting until the price of the stock is low enough. Only a fair price in comparison to what the business is worth will lead to a high return on your investment and less risk.
3. Think independently
Always make an investment case for yourself. Why is this a good business and why will the performance of the business improve?
Learn more about forming an investment expectation here.
Hard work to do the research is needed. This will also help to control your emotions. “Unsuccessful are dominated by emotion” according to Seth Klarman (see his book Margin of Safety). Savings accumulated over the years are blindly ‘invested’ in minutes due to a lack of self-control.
As Benjamin Graham said: you’re right because of your facts and reasoning. Not because people agree or disagree with you. So, don’t forget to write down the rationale of your investment. E.g. the business is worth $‘X’ because of the cash flow and return on investment of the company. The company has a moat (competitive advantage) and good management. This ensures that the company will still be around in 10 years. Additionally, I can buy it at a fair price that I have determined from a discounted cash flow analysis.
4. Have self-confidence
You must be sure about your reasoning. Fear can lead to selling an investment when the price goes even lower. If you have self-confidence, then you are more likely to buy more of the stock at lower prices. A good business will not go bankrupt (otherwise it’s not a good business). If in doubt, then it might be better to research another stock.
Buffett compares this behavior to buying a house for $100,000 and then selling it the next day for $80,000 due to a new bid. So, ignore the noise. Your self-confidence combined with the research will help to concentrate your money in a few outstanding businesses. This will lead to a good performing investment portfolio.
5. Accept it if you don’t know something
Stay within your circle of competence. Only buy companies that you understand. How do they make money and how will they make money in the future? If you don’t grasp the business model of the company, then you’re not able to make realistic long-term cash flow predictions. Fortunately, there are enough businesses that you will understand after reading the annual reports.
6. Be flexible and don’t overpay
Always calculate the price of the business and determine what you need to pay today to get a good return. Ask yourself: how sure am I about the predicted future cash flows? Keeping a margin of safety will help to reduce the chance of overpaying. Flexibility will help to switch between companies and industries if needed. Especially if the moat of the company disappears over time.
Additional investor behavior requirements
John Train mentions four additional requirements that will determine the success of the investor:
- 10-15 years of training (ideally from great investors)
- Be a genius of sorts
- Have intellectual honesty
- Avoid significant distractions
Basically, these four requirements mention the value of experience and focus. Excellent investors are honest about their mistakes. Furthermore, they don’t get distracted by outside information (e.g. short-term Wall Street opinions).
Remember from the Warren Buffett Principles
Select excellent businesses that you believe in. If you panic, then you probably didn’t do your homework well enough. A good business will get through economic recessions. Understand the risk of investing.The quality of the business and the management determine the risk of losing money.
Essential investor behavior
The big secret of investing is having the patience to wait for the perfect pitch and then let the investment compound over the long-term. A good business can let your dollars grow by reinvesting it at a high rate of return. The individual investor has the big advantage of not having to report quarterly about his investment returns.
Worst enemy is the investor himself as the wrong investor behavior can cause serious damage to your wealth. Ensure yourself of the quality of the businesses you buy and take advantage of price declines. Discipline, allocating research time and patience are key. If in doubt of your own behavior, stick with Index Funds.